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SEC staff floats compromise on transition to IFRS.

Nearly
a decade after FASB and the International Accounting Standards Board
(IASB) agreed to converge their standards in “The Norwalk
Agreement,” the SEC staff floated a concept in May that would
redefine convergence and establish FASB as an endorsement body for
IASB standards in the U.S.

The
paper (available at tinyurl.com/3wkej8m) outlines
a concept informally referred to as “condorsement” that was first
mentioned in December by SEC Deputy Chief Accountant Paul Beswick at
the AICPA National Conference on Current SEC and PCAOB Developments.

The
SEC staff was careful to emphasize that its “discussion in this
Staff Paper is not intended to suggest that the Commission has
determined to incorporate IFRS or that the discussed framework is
the preferred approach or would be the only possible approach.”

The
paper, which was published as an update on the SEC staff’s work plan
for global accounting standards, also summarizes other
jurisdictions’ approaches to incorporating IFRS. But the SEC’s
exploration of the concept at a time when public companies and
others are waiting for signs from the regulator on IFRS would
suggest it warrants scrutiny.

CONVERGENCE
VS. ENDORSEMENT

Under
the convergence approach, jurisdictions do not adopt IFRS as
issued by the IASB or incorporate IFRS into their accounting
standards directly, according to the SEC staff paper. Instead, these
jurisdictions maintain their local standards but make efforts to
converge those bodies of standards with IFRS over time.

One
example of a country using the convergence approach is China, which
is moving its standards closer to IFRS without incorporating IFRS
fully into its national financial reporting framework, according to
the SEC paper. China has indicated that it intends to eliminate the
existing differences between its Accounting Standards for Business
Enterprises and IFRS.

A
footnote in the staff paper explains that joint projects between
FASB and the IASB, often called “convergence” projects under its
Memorandum of Understanding (MoU), differ from the convergence
approach the staff is describing. This is because “[t]he FASB-IASB
process involves movement by both standard setters toward a new,
mutually-acceptable high-quality standard, while the Convergence
Approach [the staff is describing] involves movement by a country
toward existing IFRS.”

The
problem the SEC staff is attempting to address here, according to
IBM Director of IFRS Policy Aaron Anderson, CPA, is that “frankly
here we are with not a whole lot done on the MoU” since 2002.

Alternatively,
based on the staff’s research, a large number of countries,
including many in the European Union, appear to be following a form
of the endorsement approach. Under this approach,
jurisdictions incorporate individual IFRSs into their local body of
standards. Many of these jurisdictions use stated criteria for
endorsement, which are designed to protect stakeholders in these jurisdictions.

“If
you look at how other countries have gone about this process, most
of them have not outsourced standard setting entirely,” said
Deloitte partner D.J. Gannon, CPA, who leads the firm’s IFRS Centre
of Excellence. “They’ve maintained some notion of a national
standard setter. This document is essentially saying that we can
leverage what we do in the U.S. vis-a-vis FASB.”

The
degree of deviation from IFRS as issued by the IASB can vary under
endorsement. In some cases, the SEC staff observes, countries appear
to adopt standards exactly as issued by the IASB with a high
threshold for any country-specific deviation. In other cases,
countries translate IFRS as issued by the IASB into their local
language. Because words or expressions may not have direct
equivalents in some languages, translated versions of IFRS may be
understood and applied differently from IFRS as issued by the IASB
in English.

In
still other cases, countries make modifications or additions to
individual IFRSs upon incorporation for various reasons such as to
address the perceived need for country- or industry-specific
guidance or to incorporate interpretative guidance previously issued
by a jurisdiction’s regulator.

“CONDORSEMENT” FRAMEWORK

The
framework idea outlined in the SEC staff paper would incorporate the
two most prevalent methods of IFRS incorporation—convergence and
endorsement—by using a form of convergence to transition to an
operating framework that draws primarily from the endorsement
approach (see Exhibit 1).

The
framework would retain FASB as the U.S. standard setter to
facilitate the transition process by incorporating existing IFRS
into U.S. GAAP over a defined period of time such as five to seven
years, the paper notes.

After
the transition is complete, FASB would continue as the U.S.
“endorsement” body that would ensure ongoing changes to IFRS meet
the needs of U.S. stakeholders. “At the end of this [transition]
period, the objective would be that a U.S. issuer compliant with
U.S. GAAP should also be able to represent that it is compliant with
IFRS as issued by the IASB,” the paper says.

“I
think it is a compromise,” said IBM’s Anderson. “You have a certain
camp of people who want IFRS to happen now and a second camp of
people that believe IFRS should never happen. … I think it is the
best approach that has the best chance of getting over the finish line.”

However,
Anderson isn’t sure it’s the best approach for everyone, including
IBM. “I think for some companies it will be and for a lot of others
it won’t be. That’s why I think that, if they do go down this
approach, they’ll need to either mandate IFRS first for some listed
companies or at least allow the option [to report under IFRS] prior
to the endorsement part of the approach.”

TIMELINE
AND CHALLENGES

An
important question for financial statement preparers is what the
“defined period of time” would be for FASB to incorporate existing
IFRS into U.S. GAAP.

“I
think the SEC [staff] has stopped short on the details that would
really help companies understand how they would go about managing
this project,” Anderson said. “For example, when will [the defined
period of time] start and when will it end? And more importantly, is
this a standard setter’s timeline or a regulator’s timeline?”

FASB’s
evaluation will be an important element in the transition. “[FASB]
is in the power seat,” Anderson said. “They’re the ones who are
going to have to make this work and will be at the center of this transition.”

However,
some aspects of this transition appear too big for FASB to manage
alone, according to Anderson, who cites as an example the tax
consequences of a potential abandonment of LIFO, which does not
exist under IFRS.

IFRS
AS ADOPTED BY FASB

The
potential framework leaves open the possibility for FASB to carve
out differences. “FASB would retain the authority to modify or add
to the requirements of the IFRS incorporated into U.S. GAAP, similar
to other jurisdictions, and such U.S.-specific modifications would
be subject to an established incorporation protocol,” the paper says.

Under
the framework, FASB would initially address a need for guidance by
informing the IASB of potential gaps in authoritative guidance and
providing a recommended solution to address the practice issues. But
ultimately, the paper says, if FASB concludes an acceptable solution
has not been reached in a time frame consistent with the needs of
U.S. capital markets, FASB could exercise its authority by:

Adding
disclosure requirements to address U.S. circumstances in a
manner consistent with IFRS;

Prescribing
which of two or more alternative accounting treatments permitted
by IFRS on a particular issue should be adopted by U.S. issuers;
or

Setting
requirements compatible with IFRS on issues not addressed
specifically by IFRS.

“In
particular, the FASB could decide to carry forward certain such
requirements that already exist in U.S. GAAP, with any necessary
conforming amendments,” the paper says.

Acknowledging
the concern that a U.S. flavor of IFRS could develop, the paper says
that U.S.-specific circumstances for which FASB would consider
modifying IFRS should be “rare and generally avoidable.” The
objective would be for U.S. GAAP to remain consistent with IFRS, and
FASB would exercise its authority to issue any requirement in
conflict with IFRS in only unusual circumstances.

THREE-PART
TRANSITION STRATEGY

The
staff designates its potential transition according to a
classification of ongoing and expected standard-setting efforts.

Category
1: IFRSs subject to MoU projects. “While
deliberations on these [MoU] projects are ongoing at the date of
publication of this Staff Paper, for purposes of explaining the
framework, the Staff has assumed that reasonably converged standards
will be issued for each of these projects in 2011,” the paper says.
It further explains that “these projects would be expected to have
little effect on the transition plan, as both U.S. issuers and
entities applying IFRS would be required to follow the effective
date and transition provisions specified in each standard resulting
from the MoU projects.”

The
paper doesn’t say explicitly when FASB would stop setting new U.S.
GAAP. “I think the expectation is that once the current [MoU] agenda
is completed, FASB would really focus its energies on this exercise
of merging IFRS into the codification,” said Deloitte’s Gannon.
“There could certainly be interpretive issues along the way, but I
wouldn’t expect any major revisions, any major standards.”

Gannon
also pointed out that the setting of private company GAAP is a
separate issue that the Financial Accounting Foundation (FASB’s
oversight body) would need to deal with.

Category
2: IFRSs included on the IASB’s current standard-setting agenda. In
this transitional phase, the staff paper says, “FASB would need to
evaluate the magnitude of standard setting expected in order to
identify and isolate those IFRSs expected to be newly issued or
modified significantly in the near term.” It says the corresponding
U.S. GAAP requirements would remain intact until the IASB issued its
standards and FASB would participate in the IASB’s standard-setting
process, but apparently not in the same type of joint deliberations
as with the MoU projects.

When
the IASB standards are finalized, FASB would review the individual
standards to determine how to incorporate them into U.S. GAAP. “The
primary purposes of the FASB’s analysis and evaluation would be to
facilitate its incorporation of the IFRSs into U.S. GAAP, to enable
it to assist in the education of U.S. constituents, and to raise
awareness of potential implementation issues rather than to modify
the requirements of the IFRSs upon incorporation,” the paper says.

In
addition, the staff paper says FASB would need to consider whether
elements of U.S. GAAP that were not replaced by the requirements of
one or more IFRSs should be retained, removed or modified.

How
exactly this would work without creating new GAAP remains a
question. “Accounting standards by definition and practice are
linked to each other; and, when you break those links intentionally
or unintentionally, you could create a third GAAP,” Anderson said.

Category
3: All other existing IFRSs and areas not addressed by IFRS. The
staff paper says FASB’s process for evaluating and incorporating
IFRSs included in this category would be “broadly analogous to the
processes described above for IFRSs included in category 2,
including the development of a transition plan in collaboration with
the [SEC] staff.” It also suggests, “FASB may determine that all of
the category 3 IFRSs should be incorporated into U.S. GAAP
simultaneously or staged over a period of time.”

“I
think some companies will find that a big bang or adoption approach
will minimize [implementation] costs. I think the cost will be much
higher under [a multistage] approach, especially for a company like
ours,” said IBM’s Anderson.

EXECUTIVE SUMMARY

An
SEC staff paper published in May floats a concept informally
referred to as “condorsement” that
would redefine convergence and establish FASB as an endorsement
body for IASB standards.

Under the convergence approach, jurisdictions do not
adopt IFRS as issued by the IASB or incorporate IFRS into their
accounting standards directly. Instead,
these jurisdictions maintain their local standards but make
efforts to converge those bodies of standards with IFRS over
time.

Under the endorsement approach, jurisdictions incorporate
individual IFRSs into their local body of standards. Many
of these jurisdictions use stated criteria for endorsement, which
are designed to protect stakeholders in these jurisdictions.

The
framework idea outlined in the SEC staff paper would incorporate
the two most prevalent methods of IFRS incorporation—convergence
and endorsement—by
using a form of convergence to transition to an operating
framework that draws primarily from the endorsement
approach.

The
potential framework leaves open the possibility for FASB to
carve out differences, but
only in unusual circumstances that should be “rare and generally
avoidable.”

The
transition would be organized according to a classification of
ongoing and expected standard-setting efforts. Category
1: IFRSs subject to MoU projects; Category 2: IFRSs included on
the IASB’s current standard-setting agenda; and Category 3: All
other existing IFRSs and areas not addressed by
IFRS.

Matthew
G. Lamoreaux is
a JofA
senior editor.

To
comment on this article or to suggest an idea for another
article, contact Kim Nilsen, editorial director, at knilsen@aicpa.org or
919-402-4048.

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